Construction Model - Sources an Uses question

skiermike123's picture
Rank: Chimp | 7

Hey everyone - question about a construction model I'm having problems with:

Okay, so in this model we're building a small complex of apartment buildings. Each building is being developed, shortly leased up, and sold. In total, there are five buildings, and the construction period, lease up periods and sale times overlap - for instance, the first building will have leased up and sold by the time the last building is built.

Assume for the moment we're going to do this all with one construction loan with interest reserves. The lender is going to lend 70% of hard and soft costs. Equity funds before debt, and any NOI resulting from any of the buildings is going to fund the draws first (i.e. if we have a construction draw on building 5 for $100k, but building 2 returns $20k in NOI, that $20k will be applied to the draw first, the remaining $80k will be a draw that adds on to principal). Same for sales of buildings - if we sell building 1 while the construction is underway, proceeds will first go to the loan balance and then, to the extent that there is any left over, back to GP/LPs.

Here's the problem I'm having: if I total up hard and soft costs, lets say I get $2m. 70% of that is $1.4M and that's what the bank would fund. HOWEVER, because we're constantly paying down and drawing up the loan balance, the max loan balance only ever gets to $1.2m. Which goes to sources and uses?

If I put $1.4M in Sources/Uses, it balances, but we never actually use $1.4M of bank debt. If I put $1.2M, it doesn't balance, but the max loan is correct. If I put that $1.2M, it seems like the offset would be the NOI or sales proceeds used as an additional "source", but if I plug those in... it still doesn't balance.

Am I thinking about this correctly in general, or am I screwed up somewhere?

Thanks in advance.

Comments (9)

Jul 22, 2016

Sounds like an A&D loan for Townhomes - fund the purchase and costs associated with the acquisition and improvement of the site with equity and loan proceeds then 100% of the development costs with loan proceeds. I candidly only have experience working on one of these deals so don't know all the nuances.

You can't look at it as a standard development loan b/c while they commit to that "70%" you're never actually drawing it fully down like you reference above and in reality it's only a 60% or whatever LTC that's drawn on.

Jul 22, 2016

I'd have to see the model to know for sure, but double check your model, you might have two sources and uses sheets - one for the construction period and one for the operation period. If that's the case there's a chance you might not be including you proceeds of sales in the construction sources.

Also, you're better off getting a loan for $1.4 in case you don't make those sales as quickly as you expect. You need to be sure you'll at least finish construction irrespective of how quickly you sell those units.

Jul 26, 2016

Thanks guys - sorry for my slow response, been out of town and moving our house... painful.

I think you're right, part of it is that some of the source is from NOI during the operational period and part from the sales of the buildings, and these aren't showing up on sources. I think I can fix that, but I still don't think it will balance.

Conceptually, here's another thing that's really bothering me. Part of this is a question for whatever bank lends on the deal, but there may be a conventional or accepted wisdom on this:

Basically, let's say, again, that we have total costs of $2m, and the bank will loan a total of 70% of that ($1.4M). Here's what's bothering me: on one hand, the max loan balance never gets to $1.4M because while we're drawing up the loan balance, we're also paying it back through NOI and sales proceeds. This makes sense. HOWEVER, if I total up ALL the construction draws made from debt (i.e. after all the initial equity is contributed), I get more than $1.4M - like $1.5M.

Imagine it like this: we draw up to a loan balance of $1.3M in construction draws and accrued interest, then sell a building and $100k of that goes to paying down the loan balance. We continue building on other buildings in the complex, and draw it back up to $1.3M again, then pay down $100k, then draw it up to $1.3M again, then we sell off the final buildings, repaying the loan in full. Total draws were $1.3M+$100k+100K = $1.5M. While we never went over the $1.4M limit agreed upon when the deal started, total draws were, in fact, more than that $1.4M.

Any ideas as to how the bank would look at this if they set a 70% LTC limit? Does this mean that "sources" were $1.5M of construction debt, or is it really $1.3M of debt + $200k of equity from sales proceeds?

Much appreciated,

SM

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Jul 26, 2016

I know exactly where your confusion is - these deals with continuous takedown always feel tricky.

At my firm we always put aggregate debt in sources and uses, and every lender does the same on their term sheet. The lender will also stipulate how high your revolving debt can get. For modeling purposes, look at it as if the only variable the lender cares about is how much equity you contribute. If you're modeling for a 70% LTC, they're gonna want to see you cover 30% and just let the draws flow through the model from there.

In my experience, banks are always very willing to work with you on these deals - they want to maximize the $$ they have at work. I wouldn't be hesitant to ask them directly.

Another thing though - if your deal is a bit skinny, I would consider retaining some of that interim NOI rather than reducing your draws. Squeeze a little more leverage out and just hit whatever paydown % the bank requires

Jul 26, 2016

Ahhh... interesting. This is basically the conclusion that I have come to in modeling this surprisingly complicated deal. In reality - continuing our example - the real construction draws are $1.5M even though we never hit the max LTC of 70% stipulated by the bank (of $1.4M). But, in reality, that is the source of the capital: construction draws. So while 70% may pencil out to $1.4M and we never actually get there, funding is, in fact, more than that. Interestingly, if I plug in the total amount of loan draws ($1.5M in this example), the model balances just fine.

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Jul 28, 2016

So you can size it this way for the Sources & Uses of Funds and sweep in the interest expense. From an intuitive standpoint your sense that it looks a little wonky since the interest expense in your budget looks low is correct.

The clean way to visualize it in your Sources & Uses of funds is to run a max balance function across your OPB and throw it under the Sources & Uses (Sources Side) as "Maximum Usage" which is fairly typical. So even though your sizing to 70% LTC on your total budget all in with interest expense you may only draw up to a conceptual 55% depending on cash in/out management during the loan.

So how your trying to arrive at construction interest is correct. The thing for the lender is that they will want points on the 70% commitment even if your planning on drawing only 55%.

A follow-up question I would have with you is whats your project duration? If your talking about a long term multi-phase deal your going to likely break these out into 12+6 month single loans versus one giant revolver.

Hope this helps.

Jul 28, 2016

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Jul 28, 2016
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